A somewhat unreal debate is taking place over whether the country's burgeoning foreign exchange reserves should be used to finance infrastructure development, as proposed by the deputy chairman of the Planning Commission and not particularly liked by the Union finance ministry. It is unreal because the wrong issues are getting highlighted.

An issue, which has barely been discussed (it should be integral to this debate) is whether we have the right exchange rate policy. It can be argued: don't keep artificially pulling the rupee down and adding to reserves and creating an unnecessary controversy over what to do with them.

The RBI should first allow the rupee to float up to the point where it ceases to be a net buyer of dollars and then go on bidding down the dollar a little more with the accumulated dollars.

Then eventually the reserves will be just right, no more will be added to them and we will be spared the task of deciding what to do with them.

But there is a fair amount of consensus that the RBI should smoothen out sharp fluctuations in the value of the rupee and let it float up or down, whichever way the market wants, so long as it happens in an orderly fashion.

As this is likely to add to reserves in the next few months, the excess reserves issue will not go away. At the present juncture, our exchange rate policy makes for burgeoning reserves.

A stronger rupee would have meant cheaper imports, less imported inflationary pressure, and only a marginal and manageable impact on exports (the import content of exports is going up). But there is no lobby in favour of a stronger rupee.

The next issue is that it is not really dollars and euros but rupees for infrastructure investment that is the bone of contention. Hard currencies are good for importing things, and reserves would have been hugely useful till into the nineties.

Today anybody who wants to import whatever can mostly get the foreign exchange from a bank in India or borrow overseas. This is equally true of the government and private entities. What is more, the import content of most infrastructure projects will be limited, other than, say, acquiring commercial airplanes.

So the real issue is if the foreign exchange reserves can be used to generate rupees for infrastructure projects in a non-inflationary manner and without damaging the fisc.

If there were no policy or regulatory bottlenecks (like half-finished power sector reforms) standing in the way of private investment in infrastructure and if the returns were adequate, then most of the problems of infrastructure could be taken care of through commercial lending to privately funded infrastructure projects.

Even if policy issues could be taken care of, the issue of returns would remain. Returns on investment in infrastructure projects tend to be low and take a long time to come.

The answer to that lies in tax breaks for infrastructure investment and developing the long-term bond market. If private investment in infrastructure can be encouraged, then substantial or total public funding can be restricted to the supply of public goods.

A debate is on today because increasingly large numbers of people feel that large-scale, across the board, and rapid investment in infrastructure is urgently needed and cannot wait for policies to encourage private investment to produce results.

People are increasingly pointing to China and swearing by the adage: infrastructure leads, growth follows. They further argue: think of what will happen if we don't rapidly escalate infrastructure investment. In a couple of years there will be acute bottlenecks, growth will slow down, and most likely inflation will pose a serious challenge.

In order to accelerate growth, reduce poverty, and reduce imbalances that are socially divisive, it is imperative to rapidly up infrastructure investment.

Some argue that using reserves to fund infrastructure investment, when most of the money will be spent domestically, will be inflationary. But they forget that in the absence of such investment, the economy is likely to be visited by inflation and decelerating growth.

They again point to China living with high growth and moderately (sometimes plainly high) levels of inflation for a long time, to the great benefit of the Chinese economy and most of its citizens.

Lastly, there is the issue of fiscal correction. Until well into last year, the Fund-Bank line of thinking was that India was heading for serious trouble if it did not rapidly correct its fiscal imbalance. Now the perception is changed.

The Indian economy is credited with a lot more robustness despite the continued imbalance of the fisc. It is vitally necessary to go beyond the magnitude of the fisc imbalance to its composition. Your overall cholesterol level is important but there are also good and bad cholesterols.

So it is with what creates a fiscal deficit. Are you simply paying higher government salaries according the diktats of successive pay commissions, or are you building roads, which will economically transform entire regions?

The crux of the matter is almost a question of belief. If you are driven by the theology of the Washington consensus, pushed through by the Fund and the Bank, you will be obsessed by how pretty the fisc looks and will be loath to have fiscal red also blotch your own copy book.

You will worry about inflation before worrying about growth and jobs. You will not think that an effective way to ease inflationary pressure is to lower import duties, particularly when oil prices go through the roof, and bring windfall gains to the exchequer through ad valorem duties!